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Competitive market characteristics
Market with many buyers and sellers, trading identical products, each buyer and seller is a price taker, firms can freely enter or exit the market
Firm in a competitive market
tries to maximize profit
Profit formula
Profit= total revenue - total cost
Total revenue
proportional to the amount of output
total revenue formula
TR = P x Q
Average revenue formula
AR = TR / Q
marginal revenue
amount that you make from a product
Marginal cost
the amount that it cost you to make the product
marginal revenue formula
MR= change in total revenue/ change in quantity
for competitive firms
AR=P
MR=P
Goal of firm
maximize profit= TR-TC
How do you find the Quantity to maximize profit?
comparing marginal revenue with marginal cost
MR (marginal revenue) > MC (marginal cost)
firms should increase its output to raise profit
MR (marginal revenue) < MC (marginal cost)
firms should decrease its output to raise profit
What happens at profit-maximizing level?
MR = MC
marginal-cost curve
determine the quantity of the good the firm is willing to supply at any price, it is also the supply curve
MC curve
upward sloping
ATC curve
U-shaped
When does the MC curve cross the ATC curve
at the ATC curve's minimum
the price line is horizontal
P = AR = MR
MR = MC
profit maximizing level of output
marginal-cost curve
determines the quantity of the good the firm is willing to supply at any price (is the supply curve, starting minimum average cost point)
shutdown
a short-run decision not to produce anything during a specific period of time because of current market conditions, firm still has to pay fixed cost
Exit
long-run decision to leave the market, firm doesn't have to pay any costs
the firm's short-run decision to shut down
cost of shutting down: TR= total revenue (revenue loss)
benefit of shutting down: VC= variable costs (cost saving)
When should a firm shut down?
If the TR < VC (or P < AVC)
Short-run supply curve
the portion of its marginal-cost curve that lies above average variable cost
Sunk cost
A cost that has already been committed and cannot be recovered, should be ignored when making decisions
In the short run...
fixed costs are sunk cost, FC should not matter in the decision to shut down
firm's long-run decision
1. Cost of exiting market = Revenue loss = TR
2. Benefit of exiting market = cost saving = TC
Exit the market if....
Total revenue < total cost; TR < TC (same as: P < ATC)
Enter the market if....
total revenue > total cost; TR > TC (same as: P > ATC )
competitive firm's long-run supply curve
The portion of its marginal-cost curve that lies about average total cost
If P > ATC
Profit = TR-TC = (P- ATC) Q
(measuring profit)
If P < ATC
Loss = TC - TR = (ATC-P) Q
(negative profit)
Assumption
All existing firms and potential entrants have identical cost curves, Each firm's cost does not change as other firms enter or exit the market
Number of firms (short run)
Number of firms is fixed (due to fixed costs)
Number of firms (long run)
Variable (due to free entry and exit)
As long P > AVC
Each firm will produce its profit-maximizing quantity, where MR = MC
For P > AVC
supply curve is MC curve
Long-run
firms can enter and exit the market
P > ATC (long-run)
firms make positive profit (new firms enter the market)
P < ATC (long-run)
firms make negative profit (firms exit the market)
Process of entry and exit ends whens
Firms still in market make zero economic profit ( P= ATC) because MC= ATC : efficient scale
Long run supply curve is perfectly elastic
Horizontal at minimum ATC
Why do competitive firms stay in business if they make zero profit?
Profit= Total revenue- Total cost, total cost includes all opportunity costs
Zero-profit equilibrium
Economic profit is zero, Accounting profit is positive
Long-run equilibrium
P = minimum ATC
increase in demand
demand curve shifts outward
short run effect of an increase in demand
higher demand → higher price→ Higher price: P > ATC→ positive economic profit→ encourages new firms to enter the market
Long-run (increase in demand)
Firms enter the market (due to short run) → Short-run supply curve shifts right → Price decreases back to minimum ATC, Quantity increases because the market now has more firms to satisfy the greater demand.
Why is the long-run supply curve is typically more elastic than the short-run supply curve?
Because firms can enter and exit more quickly in the long-run than in the short-run
